Why This Isn’t a Bitcoin Bubble

Bitcoins today surpassed the $30/bitcoin mark, which for many was a landmark price point following the “bitcoin bust” of mid-2011. But similarly it is opening up old wounds and causing fear in many that bitcoin is just bubbling up only to pop again shortly.

I don’t believe this to be accurate, and I’d like to make my case.

This recent price trend is not new or foreign to bitcoin. Take a look at the three graphs below from various times in the history of bitcoin.

In early 2011 there was a similar price graph, from below $1/BTC to over $3.50/BTC, an increase over a month or so of 250% and a maximum increase in a single day of about 22% – while we all know it continued on to a 3100% increase (all the way up to £31.91/BTC), it never again dropped below $2/BTC (and is now again up at the $30 price point)

Following the bitcoin bust, in late 2011/early 2012 we saw a similar graph of growth, from about $2.50/BTC all the way up to $7/BTC. An increase of 180% and with a maximum daily price increase of around 35%. It briefly retracted follow this, but certainly not substantially, and remained in growth in relation to the graphed time period.

In mid 2012 this graph saw a doubling of the price per bitcoin, and while it retracted briefly back to $10 (via the approx $13.50 mark) this still represented a doubling in price.

And this is the most recent graph. The growth is arguably more steady, the growth rate is very similar to the above graphs, and it represents a mere doubling of value in the graphed time frame. In comparison to the previous non-bubble graphs, this too is a non-bubble graph.

Now compare this with the infamous growth/retraction graph.

This is what you would have seen if you were trading bitcoins in the first half of 2011. A value increase of circa 3100% in under 2 months. Compare this to the current growth of a mere 100% over a 2 month period, and the difference is stark.

So what caused the massive growth in bitcoin in 2011? And how is it different to today.

This graph shows the traffic stats for bitcoin.org in the 2011 period, and also forward to the present day. As you can see in 2011 the interest in bitcoin was absolutely phenomenal and vastly exceeds today’s interest (if interest can indeed be measured by the traffic to bitcoin.org) – this interest is clearly related to the increase in price of bitcoins as loads of opportunists tried to get a piece of the bitcoin pie.

A potential cause of both the interest and the resulting price increase is the media covered received by bitcoin. This again is a very un-natural growth graph with a huge spike in news headlines that corresponds directly with the growth and retraction of bitcoin circa 2011. If we were to draw a line directly through that spike we see a very nice linear growth rate in news coverage. We also clearly see that there is no similar influx of media hype driving up the current price.

And an overlay of the all-time price chart with the news headlines chart is almost uncanny – the only real difference is how growth in bitcoins is out-stripping the relative media attention. Correlation or causation? I can but guess.

Lets look at some of the other merits of bitcoins present, vs bitcoins circa 2011.

The number of transactions per day is growing at a strong and rapid rate, this is a key figure because it shows actual usage of bitcoins, an increase in which is positive for the bitcoin community and directly relates to the price per bitcoin.

The equivalent graph showing the usage of bitcoin in their USD value shows a 10 fold usage increase in just the past year. That is extremely significant, and perhaps illustrates the significance of bitcoin growth best of all the graphs in this article.

The strength and longevity of bitcoin also relies on the strength of the network. The rewards for keeping the network strong into the indefinite future (remembering bitcoin mining isn’t the only way to earn bitcoins, and definitely isn’t indefinite) shows a 10 fold increase in this critical metric for the sustainability of bitcoin.

And a final graph that I think lends further support to the current price of bitcoin, relates to the bitcoin mining reward halving of November 2012. The chart above shows the operating margin for a bitcoin mining operation, and the impact on profitability of the halving process. Before the halving I wasn’t sure how to guestimate what affect it would have on the price of bitcoin. I’m sure I wasn’t alone in that, and I’m sure the uncertainty held many people back from buying into bitcoin.

In retrospect, logically one of the biggest groups to consistently place sell orders on exchanges would be miners. If a miner isn’t operating profitably it stands to reason they might also hold off on selling coins into the market, or they might look to support the price of bitcoins to find themselves profitability once more.

Another direct result of the “halving” was that fewer bitcoins were actually being sold into the market because fewer bitcoins were mined. While bitcoin had found some semblance of balance, with fewer sell orders, naturally the buy orders gain the upper hand and the price goes up. On some days pre-halving the volume of transactions on the exchanges matched the number of bitcoins mined that day. In other words, the movement in the markets could purely have been bitcoins mined that day being sold into the market.

The reduction in mined bitcoins can therefore be directly attributed to a reduction in sell orders, which is in turn directly attributed to a proportional increase in buy orders, and therefore an increase in the price per BTC.

Conclusion

For the foregoing reasons, I think it is fair and reasonable to conclude the current price graph of bitcoins is not a bubble, and is indeed somewhat sustainable.

The first bitcoin bubble and bust (although I’d argue it too wasn’t a bubble, or shouldn’t have beem) was based on media hype, rather than real data. This growth graph reverses that influence.

Bitcoin is in a part of its lifecycle where this kind of strength also becomes a self fulfilling prophecy.

2 thoughts on “Why This Isn’t a Bitcoin Bubble”

However, one grouchiness: I think the volume of bitcoin transactions is not a good indicator because of Satoshi Dice. This are transactions which have low risk and are very easy, and Satoshi Dice has led to a large increase in the number of transactions.

I think it would be more informative to look at some net exchange volumes at the bitcoin exchanges, like MtGox, volume of depositis at InstaWallet or total purchases from merchants using BitPay and similar services.

But beyond that objection, it looks like Bitcoin is taking off.

One effect which could become very strong in future is the network effect.

Imagine you have 10,000 merchants who sell for bitcoins, and 100,000 buyers. If you add 1000 merchants or 10,000 buyers, the economy would increase by 10 %. That would be linear growth.

However one important thing that bitcoin makes possible, and is a critical aspect of currencies (and so-called social networking sites as well), is the network effect. That means if you have N=100 people, there are

N * (N-1)/ 2

possible connections between them. And if you add one person to get N+1=101, there are

(N+1) * N / 2

connections – that are N connections more! If you add 10 % more bitcoin users, you get 21 % more connections. And easy transactions of small amounts between individuals is an area where the virtues of bitcoin shine.

(I think this is a good reason for social networking sites and business networks to include bitcoin support into their sites – it would not only strengthen connections within the bitcoin economy, but also boost links between their members. )

While I completely agree that Satoshi Dice accounts for a large volume of transactions, this is the reason why the USD transaction volume is so important, and it doesn’t really matter if that graph has come from SD, or from silkroad, or from etc etc etc. The simple fact of the matter is the total usage of bitcoin is growing, which is an incredibly important factor.

I also don’t think look at volumes on exchanges is a great way to go because the value of bitcoin as an investment relies heavily on the usefulness of bitcoin as a currency. The point of this article was to explain why I don’t believe this is a bitcoin bubble, and my reasoning is based on the usefulness and usage, not on the investors.